DBRS Downgrades The South Financial Group, Inc to BB; Trend Negative

DBRS has today downgraded the ratings of The South Financial Group, Inc. (The South or the Company) and its related entities, including its Issuer & Senior Debt rating to BB from BBB (low). At the same time, DBRS downgraded The South’s banking subsidiary’s Deposit & Senior debt rating to BB (high) from BBB. All ratings were placed on Negative trend.

Today’s rating actions conclude a review with Negative Implications initiated by DBRS in April 2009. The downgrade reflects The South’s struggle with steepening asset quality deterioration over the past year and a half, given its moderate earnings capacity, and DBRS’s expectation of sustained elevated credit costs and expenses going forward. Even excluding recent goodwill impairment charges, recent results have been negatively impacted by high credit costs and expenses, mostly related to the Company’s sizeable Florida commercial real estate portfolio (CRE). Furthermore, DBRS remains concerned with the higher risk nature of the Company’s significant CRE concentration.

The Negative ratings trend reflects DBRS’s perception that substantial amounts of potential losses remain embedded in the Company’s loan portfolios, especially given declining real estate valuations and rising unemployment. Moreover, DBRS comments that The South’s financial flexibility in raising future capital will be somewhat limited after it completes its capital plan. DBRS notes that sustained elevated asset quality erosion will likely result in negative rating actions.

The South’s ratings reflect its augmented capital position, adequate liquidity, and its presence in the highly stressed, yet demographically attractive states of South Carolina, North Carolina and Florida. Ratings also reflect the Company’s weak asset quality and continued lack of profitability.

The South reported a Q2 2009 net loss applicable to common shareholders of $111.5 million. The loss reflected a $131 million provision for loan loss reserves, a $13 million loss on OREO, a $9.4 million loss on non-mortgage loans held for sale and $7 million in loan collection and foreclosed asset expense. Partially offsetting the headwinds was a 13 basis points widening of net interest margin to 2.96%, higher service charges on deposit accounts and an increase in debit card income. DBRS notes that the expanding NIM reflected lower deposit costs.

The South’s asset quality remains severely stressed. Acquisition, construction and development loans, especially those originated in Florida represent the bulk of the Company’s loan delinquencies and charge-offs. At June 30, 2009, the South’s NPAs represented a high 5.94% of loans versus 5.08% at March 31, 2009. Meanwhile, NCOs for Q2 2009 increased to a high 4.91% of average loans, from 4.36% for the prior quarter. Roughly 68% of net charge-offs were CRE related, the majority of which was Florida based acquisition, development and construction loans. Meanwhile 67% of nonaccrual loans were CRE, of which 53% were in Florida. DBRS comments that The South’s CRE portfolio represents a concentration, constituting approximately 42% (excludes owner-occupied loans) of total loans and 5.2 times (x) tangible common equity. DBRS comments that the Company’s reserves to non-performing assets were fairly moderate at 51%. DBRS perceives that significant amounts of potential losses remain embedded in The South’s core portfolio, particularly within its residential construction and mortgage portfolios.

Positively, The South has and will continue to bolster its capital position. During Q2 2009, the company issued $75 million of common stock, which enhanced its capital ratios and provided additional loss absorption capacity. At June 30, 2009, the Company’s estimated Tier 1 and Total risk based capital ratios were solid at 12.36% and 13.65%, respectively. Additionally, the company’s tangible common equity ratio was healthy at 6.07%. During July 2009, the Company issued an additional $10 million of common stock and sold an ancillary business for a small gain. Additionally, during Q3 2009, the Company anticipates converting $190 million in mandatory convertible preferred stock to common shares, expects to tender a $25 million exchange of trust and REIT preferred securities for common stock, and anticipates additional gains from the sale of other ancillary businesses. DBRS comments that failure to accomplish these exchanges and capital builds would likely result in further rating actions.

DBRS notes that The Company’s liquidity position is adequate, yet remains somewhat pressured by a large wholesale funding reliance of 47% (as of March 31, 2009). The South’s sound quality securities portfolio, which represents roughly 15% of total assets, access to the FHLB and Federal Reserve Discount Window, round out its liquidity profile. Furthermore, The South’s parent’s fundamentals remain solid, punctuated by a sizeable cash position.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.